The Just One story is easy for me today. The Bush administration announced a plan which would essentially freeze interest rates in hopes of stemming the tide in an otherwise rising wave of home foreclosures.
It would essentially classify homeowners into a few different buckets. To make a very complicated story short, homeowners who have mortgages that have rates which will reset in the next two years and can not afford the reset, will get a reprieve from the rising interest rate they would have otherwise had to pay. Those who can afford it won’t get it (how this is determined is beyond me) and those who could have never afford even the lower rate won’t get it.
Another sticking point is to figure out a way to get investors who bought these securities to just bend over and take this. Imagine if someone promised to give you $10 a month for a year and then $30 a month every month after that. Then, when it comes time to start the $30 month payment they say, “Just kidding!”. Well that is what this plan is doing.
What about all those homeowners who complain they didn’t know what they were getting themselves into? Well I don’t feel a lot of pity for them. This was the biggest purchase they will ever have, and they didn’t try and understand what they were buying? People like me, who were careful with my money and didn’t buy when everyone else was going crazy now have to pay for this (yes we all pay for it). Doesn’t seem really fair to me. Further, the economist in me knows this plan will cause Moral Hazard going forward. Basically future homeowners will know that the government will bail them out, causing more people to take on riskier loans. Moreover, investors will suspect the same thing, and demand higher interest rates, thus making mortgages for all more expensive.
So how do you play this in the market? Still wouldn’t touch financials or stocks related to housing here. In fact, I would wait for them to bounce, and they will bounce, and then short into strength. Names like Toll Brothers were up 13% today, I think you let them go a little higher, and then short them. This mess isn’t anywhere close to over.
What do you think? Do you think this is a good plan that the government should support? If not, what would you let happen?
More Info:
Hi Terrence,
Here’s an interesting article regarding this: http://money.cnn.com/2007/12/07/real_estate/freeze_fairness.moneymag/index.htm
It basically states that although the “irresponsible” borrowers will get an interest rate freeze, their interest rates were typically several points higher than what the prime borrowers got so it really wouldn’t be much of a “bail-out.” On the other hand, if mortgage interests rates adjust every 6-12 months, these people won’t have to worry about it, while prime borrowers will. As for me, the only problem I have with this deal is what the guy mentions at the end of article: These sub-prime borrowers won’t have to keep up their end of the deal, while responsible borrowers (like my mom and I) will.
Also, although I agree with you that this deal isn’t very fair, I’m not sure how much of a Moral Hazard this will cause. I don’t think people who will be buying houses in the future will think “Yes, let’s risk ruining my credit by taking out a loan I may or may not be able to afford BECAUSE Dubya will bail me out.” People who entered into these sub-prime loans don’t really need a reason to screw up. People who are irresponsible will be irresponsible with or without the government’s help. Forgive me for the analogy, but I can’t help but compare it with who saying legalizing abortion will cause more women to get pregnant and get abortions. Having an abortion is a really traumatic experience (as I’m sure being close to losing your home is) and I don’t think women would be more eager to get it on with someone just because they can get an abortion later.
Lillian,
My problem isn’t with the moral hazard on the borrowers end, although I don’t discount it as much as you do. It most definitely exist on the other end for the investors. Loans have been possible over the last several years because investors were willing to buy them. If you introduce the idea that the contract they signed may not be valid, you make future investors weary of buying these assets, making it that much worse for people to try and get a loan.